The legal cannabis industry is budding before our eyes, and investors have certainly taken note. Over the trailing year, most marijuana stocks have catapulted higher by 100% or more. The reasons for this enthusiasm relate to rapid North American sales growth, as well as a discernable and persistent shift in favorability toward pot among the public. Within the U.S., no less than five national polls over the last year have shown overwhelming favorability toward legalizing adult-use cannabis.
All eyes on Canada
However, it's not the U.S. market that's turning heads when it comes to legal cannabis -- it's Canada. Our neighbor to the north legalized medical marijuana back in 2001, with Health Canada regulating licensing and cultivation ever since. Canada now appears to be on the doorstep of becoming the first developed country in the world -- and only the second overall behind Uruguay -- to legalize recreational weed. With a Senate vote slated for June 7, recreational pot sales could begin as soon as August or September, assuming passage.
If approved, the Cannabis Act would generate in the neighborhood of $5 billion or more in annual sales on top of what Canada is already reaping from domestic medical cannabis sales and the export of dried cannabis to legal medical weed countries (mostly in Europe). As a result, the biggest growers in Canada have been expanding their growing capacities at a rapid pace. Many have been using bought-deal offerings to organically and inorganically bolster their projected annual production.
The buzz surrounding Canada's biggest growers
Canopy Growth Corp. (NASDAQ:CGC), the largest marijuana stock by market cap, already has seven facilities spread across 665,000 square feet and is in the process of developing greenhouses on 3.7 million more square feet of growing capacity in British Columbia. Though Canopy Growth hasn't exactly been forthcoming with its annual production expectations, it wouldn't be at all surprising if it handily surpassed 300,000 kilograms per year.
Similarly strong production is expected from Aurora Cannabis (NYSE:ACB) and Aphria (NASDAQOTH: APHQF), which should be the No. 2 and No. 3 behind Canopy in terms of annual production. Through both organic projects -- Aurora Sky for Aurora Cannabis and a four-phase, 1 million-square-foot expansion for Aphria -- and massive acquisitions, Aurora Cannabis and Aphria are expected to yield a respective 283,000 kilograms and 230,000 kilograms of dried cannabis a year.
As a result of these high projected yields, Canopy Growth, Aurora Cannabis, and Aphria command hefty market caps of $5.1 billion, $4.4 billion, and $2 billion.
The Rodney Dangerfields of Canadian pot stocks
While the above trio has done exceptionally well, the Canadian pot stock industry, as a whole, has been a bit bifurcated. Don't get me wrong -- practically all Canadian pot stocks are up significantly over the past couple of years. However, other growers with relatively high projected annual cannabis yields aren't getting nearly the same premium or respect as Canopy, Aurora, or Aphria. They're what you might call the Rodney Dangerfields of the marijuana industry.
What pot stocks belong to this group? How about OrganiGram Holdings (NASDAQ:OGI), which appears to be doing everything right on paper. Its focus on a single growing facility in Moncton, New Brunswick should help keep the company's long-term costs down. Further, its predictive models underestimated the yield it would generate from its existing grow facilities. As a result, OrganiGram recently upped its expansion and production forecast to 113,000 kilograms of cannabis a year from just 65,000 kilograms a year.
Another marijuana stock that gets no respect is Emerald Health Therapeutics (OTC:EMHT.F). Emerald Health made the smart move to partner with Village Farms International last year to retrofit an existing 1.1 million-square-foot facility that Village Farms had been using to grow tomatoes. Retrofitting this existing facility for dried cannabis production saves time and money. Along with building out a 32 acre site that'll also house its headquarters, Emerald Health has as much as 5.8 million square feet it can employ for growing weed.
The Supreme Cannabis Company (OTC:SPRWF) is also getting no respect. Supreme Cannabis' lead grow site, 7Acres, spans more than 340,000 square feet. While it's also been pretty tight-lipped about its top-end growth potential, it wouldn't be in any way surprising if it neared 50,000 kilograms in annual production.
Yet if we look at the market cap of these three companies, OrganiGram, Emerald Health, and Supreme Cannabis Co. are worth $448 million, $547 million, and $376 million, respectively.
Why can't these three marijuana stocks get any respect?
So, what gives? Why can't these three growers get any respect like Canopy, Aurora, or Aphria? The answer probably boils down to three factors.
First, these growers lack the huge cash balances and deep pockets that you'll find with the likes of Canopy, Aurora Cannabis, or Aphria. As noted by Canopy during its third-quarter operating results, it has in the neighborhood of $345 million in cash and cash equivalents on hand, inclusive of bought-deal offerings completed after the quarter ended.
The reason this cash is so critical is there's a growing possibility that Canada could face a marijuana glut in the years to come. Initial domestic demand is forecast to be around 800,000 kilograms, albeit this is merely a guess since there's precedent for legalizing recreational cannabis. Comparably, total production could be twice as much, if not more, by the turn of the decade. A glut of pot could wreck cannabis margins and ransack the valuations of growers that don't have a lot of cash on hand to handle a major decline in per-gram cannabis prices.
Secondly, it could take considerably longer for these three growers to reach their maximum annual output. For instance, Emerald Health Therapeutics has 5.8 million square feet of capacity to work with, but it could take years before it has a chance to construct greenhouses to put this land to use. Similarly, OrganiGram won't have completed its expansion at Moncton until April 2020, by its own estimate. While their annual outputs won't be negligible by any means, these smaller growers could lose out to Canopy, Aurora, and Aphria, which may be able to forge long-term supply agreements by being able to ramp up their production much faster.
Finally, it's a lot harder for smaller growers to mask the effects of dilutive bought-deal offerings. Since no pot stock is generating enough in operating cash flow to fund expansion, practically all Canadian weed stocks have turned to bought-deal offerings to bolster their balance sheets. Unfortunately, this dilution is readily apparent for smaller-market-cap pot stocks that could take longer to reach their peak annual production.
For example, Supreme Cannabis Co.'s outstanding share count for its Canadian listing has ballooned from 9.6 million to more than 198 million between the end of 2013 and its most recently reported quarter. This not only dilutes existing shareholders, but it makes it considerably tougher for the company to report a meaningful per-share profit.
I'm not saying these three marijuana stocks will never get any respect from Wall Street. However, they do have quite a few obstacles to overcome before they're given anywhere near the premium that Canopy Growth, Aurora Cannabis, and Aphria currently command.